KIDS' GLOVES OFF !!!

Taking a tough stance on the spiraling inflation, RBI has announced a surprise hike in its key policy rates – repo and reverse repo –by a quarter percentage point each. This is the first increase in two years and more tightening measures are expected to follow as the central bank gears up to fight inflation. Post-increase, the repo rate stands at 3.5% and reverse repo rate at 5%.

The hike comes one month before the scheduled annual policy review and follows a 75 basis points hike in the cash reserve ratio in January. The rate hike should anchor inflationary expectations and contain inflation going forward, the central bank said. The measure also shows policy makers’ confidence in the momentum of economic recovery. As liquidity in the banking system will remain adequate, credit expansion for sustaining the recovery will not be affected.

While the headline inflation on a year-on-year basis at 9.89% exceeds RBI’s baseline projection of 8.5% for end-March and is within a striking distance of a double-digit score, India’s industrial production gained 16.7% in January following a 17.6% increase in December from a year earlier - the fastest pace in more than a decade. The high inflation was until recently perceived to be on account of supply-side factors. But, the central bank now recognises the rising demand side pressures accentuating and complicating the risk of rising inflation.

It is clear that the focus of monetary policy will now tilt towards containing the inflation and inflationary expectations, rather than worrying about a pre-mature tightening undermining the recovery. The fine print of the RBI statement indicates that the pace of the ‘calibrated exit’ would be accelerated. Please share your views.

• Will there be another 25 basis points hike in April? My expectation is YES followed by a series of hikes.
• What will be the level of the policy rates in one year from now (March 2011)? My hunch is at least 150 basis points above the current level.

War on inflation intensifies - CRR raised again

The Reserve Bank of India has announced another hike in the cash reserve ratio, as inflation continues to surge despite a slew of monetary and fiscal measures taken in the last couple of months. The 50 bps hike takes the CRR - the balance that banks need to maintain with the central bank - to 6% and will be effective in two phases of 25 bps each, first phase kicking in on 17th February and second phase starting 3rd March. The move will impound about Rs. 14,000 crore out of the banks' deposits.

It was on 8th December 2006 that the RBI had last raised CRR by 50 bps, absorbing around Rs 13,500 crore. This was followed by a 25 bps increase in the repo rate on 31st January. RBI is worried about the spiraling inflation and has been taking measures to avoid overheating of the economy as it continues to grow ferociously. See a detailed analysis of the interest rate scenario and RBI's actions here.

The Indian economy is expected to grow at 9.2% in FY2007 on the back of 9% growth last year. The annual wholesale inflation rate has touched 6.58% for the week ended 27th January - a full percentage point higher than RBI’s target for the current fiscal.

Besides the surging inflation numbers, the recent move seems to have been triggered by the rise in liquidity from RBI's intervention in the forex market in the last few days. RBI has been buying dollars to halt the appreciating rupee as a strong domestic currency affects the country's exports.

The CRR hike is bound to have an impact on banks' lending rates, including those on home loans, auto loans and personal loans. In the weeks following the recent repo rate hike, some of the private sector banks have already raised their lending rates. Public sector banks, which constitute three-quarters of India’s banking industry refrained from doing so as they were advised by the finance minister to maintain the current rates, especially on housing loans. They may have to follow suit now, as the liquidity squeeze puts pressure on their cost of funds.

RBI raises repo rate

RBI has raised the short-term repo rate by 25 bps to 7.50 per cent, while keeping reverse repo (6 per cent), bank rate (6 per cent) and CRR (5.50 percent) unchanged.

Concern over surging inflation is the dominant theme of the quarterly review of monetary policy and the hike is on expected lines as the central bank had given enough indications in its macroeconomic review that it is worried about the underlying inflationary pressures. Inflation, which had breached the 6 per cent mark in the first week of January, had eased marginally to 5.95 per cent in the following week ended January 13. The RBI’s year target band for inflation is 5-5.50 per cent. Meanwhile, the Government on its part has taken a series of fiscal measures to rein in the rising inflation.

Repo rate is the rate at which the central bank buys securities to infuse liquidity in the system and reverse repo rate is the rate at which it sucks out excess liquidity by selling securities in the market. The daily repurchase window is expected to provide a ‘corridor’ for the overnight rates, with reverse repo rate and repo rate acting as the floor and the ceiling respectively. By increasing the repo rate while keeping the reverse repo rate unchanged, RBI has widened the spread to 150 bps which has traditionally been maintained at 100 bps. Interbank overnight rates tend to stay near the repo rate in a situation of tight liquidity as prevailing now.

Echoing the all-pervasive bullish outlook on economy, the RBI has revised upwards the GDP growth projection to 8.5 to 9 per cent in 2006-07 as compared to 8 per cent projected in mid-term review and 7.5 to 8 per cent earlier. On inflation, it observed prices of food articles would have considerable impact on headline inflation over the rest of the year. The seasonal decline in prices of food articles in the second half of the year has been less than normal. The prices of manufactures are firming up and were close to the headline level by the end of December.

The central bank has re-iterated its worries on continued high credit growth in the real estate sector, also identifying outstanding credit card receivables, loans and advances qualifying as capital market exposure and personal loans as a matter of concern. It says, there are abiding concerns relating to the persistently high credit growth and the potential for erosion in the quality of credit so that balance sheets of banks need to be fortified against the build-up of loan delinquencies by precautionary provisioning and a greater sensitivity to underlying risks by enhancement of risk weights applied to advances to specific sectors in which banks’ exposures have been rising at a fast pace.

Significantly, RBI has signaled in its statement that more interest rate hikes are on the cards, as the economy continues to grow ferociously and containing inflation takes priority in policy. RBI mentions that early warning signals emanating from rising inflation in an environment of high money and credit growth indicate that monetary policy is still accommodative, warranting a policy response in terms of a measured increase in interest rates to assuage demand pressures. The stance of monetary policy has progressively shifted from an equal emphasis on price stability alongside growth to one of reinforcing price stability with immediate monetary measures.

RBI hikes cash reserve ratio to tame inflation

Reflecting the persistent worries on inflation amidst ferocious economic growth and surging forex inflows, the Reserve Bank of India has decided to raise the Cash Reserve Ratio (CRR) to 5.50 percent. CRR, a tool used by central banks to control liquidity in the system, refers to the amount of cash (as a percentage of bank deposits) that banks are required to set aside and maintain with the central bank.

Inflation, as measured by rise in wholesale price index, continues to stay near the higher end of the central bank’s target range of 5-5.50 per cent. The economy expanded 9.2 percent in the quarter ended September 30 and foreign investors have been pouring money into Indian stock markets, leading to an overwhelming liquidity surge. The current surplus liquidity in the banking system – reflected in the amounts absorbed by RBI in its daily reverse repo auctions (banks parking excess funds with RBI) – is estimated to be in the range of Rs 25,000-30,000 crore. This is on the back of a strong over 30% growth in bank lending.

“It is necessary to recognize the challenges emanating from capital flows and consequent impact on increasing liquidity”, the RBI statement notes. ``The overall impact on inflation expectations requires to be monitored and moderated.”

The CRR hike will be effected in two phases - from current 5 per cent to 5.25 per cent effective December 23 and to 5.50 per cent from January 6. The move will impound about Rs 13,500 crore of bank funds.

Related posts:

(1) 'Reddy' for another hike?

http://aktonmarkets.blogspot.com/2006/10/reddy-for-another-hike-when-reserve_28.html

(2) RBI hikes repo rate, leaves other rates unchanged

http://aktonmarkets.blogspot.com/2006/10/rbi-hikes-repo-rate-leaves-other-rates.html

RBI hikes repo rate, leaves other rates unchanged

Repo Rate – Increased to 7.25% from 7% Reverse Repo Rate – Unchanged at 6%
Bank Rate – Unchanged at 6.0 % Cash Reserve Ratio – Unchanged at 5 %

In a deft balancing act, the Reserve Bank of India increased the repo rate by 25bps to 7.25 percent, while leaving the reverse repo rate unchanged at 6 percent. Reverse repo rate and repo rate act as the floor and the ceiling providing a ‘corridor’ for the money market. Reverse repo rate is the overnight rate at which the central bank sucks out excess liquidity by selling securities in the market and repo rate is the rate at which it injects liquidity into the system by buying securities. Normally, a 100 bps spread is maintained between the two rates rates, but it has now been increased to 125 bbp. Bank Rate and CRR have also been left unchanged.

The announcement made in the mid-term review of the Annual Policy Statement for FY'07 came as a surprise for the market. Market was expecting a hike in reverse repo rate as well, in view of the pressure on inflation from a strong economic growth. Maintaining optimism about the economic growth, RBI has upped the GDP growth projection for 2006-07 to 8 percent from the earlier 7.5-8 percent. The central bank also maintains the year end (March 2007) inflation target at 5-5.50. Inflation reading for the week ended October 14 stood at 5.26%.